Feds bet on recession

Today morning I heard quite a smart guy at Boomberg radio (not sure what his name was). He made several interesting points on inflation:

1. Historically, inflation usually peaks during second half of the recession

What does it mean? If this recession indeed started in December and will end in December of ’08 it is totally normal to expect the inflation to peak somewhere in late Summer or even Autumn period.

2. When the recession starts inflation takes care of itself

It doesn’t matter what Feds do after the recession already had started, the inflation eventually fade. The hyperinflation scenario (1970s) happens because of the Feds actions before the recession

3. Feds made a huge bet that we are or soon will be in recession

The greatest risk in Feds aggressive rate cuts is not that it may fail to prevent a recession. Just in opposite. The greatest risk to the economy happens if after those aggressive rate cuts we do not fall into recession, because in that case the inflation will not take care of itself. Then Feds will be forced to raise rates to the moon and the hell will break lose.

That could explain why Feds were very tight back in January. They tried to force the economy into recession, because this is the optimal outcome. In the past few weeks they got enough evidence that we are in recession and now they can finally relax the monetary policy.

This economy needs a recession badly and, fortunately, we are in recession. All goes well, or at least according to plan 🙂

Like this:

Related

12 Responses to “Feds bet on recession”

I think it would be incorrect to think that recessions are always accompanied by deflationary prices. If that was the case, the term ‘Stagflation’ would not have been coined.

Unfortunately for us, we are going to see something worse than Stagflation – ‘Inflationary Recession’. And it would probably continue till commodity prices climb high enough to – 1. demand slows down dramatically across the globe or 2. central banks start tightening.

At that point, we could see the next phase of Recession – ‘Deflationary Recession’.

Once the debt is fully deflated (3-4 years), we could see the economy going no where (just like Japan) till around 2020-2022. I don’t expect major growth to start picking up in US till 2018 or later.

At that point, we could see the next phase of Recession – ‘Deflationary Recession’.

I think this is what is ‘badly needed’, especially regarding house and other inflated asset prices. I think the wealth destruction via deflation will be deeply felt, and the recession will be longer and more severe than otherwise because of it.

And after that occurs, the US economy has to be transformed into one that does not rely on cheap money asset bubbles and foreign dollar inflows to produce (the illusion of) ‘prosperity’.

A second big American interest-rate cut in a fortnight, alongside an economic stimulus plan that united Republicans and Democrats, demonstrates that US policymakers are keen to head off a recession that looks like the likely consequence of rising mortgage defaults and falling home prices. But there is a deeper problem that has been overlooked: the US economy relies upon asset price inflation and rising indebtedness to fuel growth…Therein lies a profound contradiction. On one hand, policy must fuel asset bubbles to keep the economy growing. On the other hand, such bubbles inevitably create financial crises when they eventually implode.

Roxy,
Like it or not, when the government issues debt, it is printing money. Prove it to yourself by putting those interest rates at zero. Essentially what is happening is that the T writes out debt, takes in cash to print checks. The banks in turn take the Ts and get cash for them from the Fed, or simply uses them for debt collateral; either way money is created.

“Once the debt is fully deflated (3-4 years), we could see the economy going no where (just like Japan) till around 2020-2022. I don’t expect major growth to start picking up in US till 2018 or later.”

Or later, since our economic model now is becoming a burden, the future requires a restructuring of economic life, without savers, strong manufacturing sector,high cost of energy just to name a few issues going forward may push out that date a few years!

PrintFaster, you’ve said it yourself that Feds need to monetize the T bills before it is converted to money.

Let see, yesterday and today combined Feds printed $18 bln. At the same time today and tomorrow Treasury debt borrows $46 bln in new notes. So I see -$28 bln drain at the markets and $46 bln add at treasury coffins that probably will go to pay current obligations, salaries, aid to Honduras and stuff like that.

I agree it is still inflational, but money are removed from high-velocity leveraged financial markets and transfered to slow-velocity pockets of public employees. As far as the salary increase of those public employees trails inflation I see no new price pressure.

Hi Roxy
The price pressure does not come within the US, it comes from without. With expanding economies elsewhere like China and Russia, price pressure will continue. With the dollar dieing, price pressure will continue since our goods are foreign.

Besides, you forgot, the US debt tends to go to banks and others like hedge funds that borrow against the debt, spinning it out again. Think of it this way, if someone handed you 1000 in cash, or 1000 discounted in a note or bill, would you have a problem in accepting either? This would not be the same if some handed you AAA commercial paper, would it?

People forget that a dollar is a promise to redeem on payment of taxes. A federal debt is deferral on payment of taxes. Money supply and not debt is floated on the promise to pay taxes. Everytime the treasury issues debt, it issues promises to pay future taxes.

Who is going to pay all the outstanding debt? My answer is inflation. The US public cannot afford the taxes. You cannot have true monetary deflation (not debt deflation) unless the government runs a budgetary surplus, taking those federal debt instruments out of the public’s hands.

PrintFaster, I agree with tendencies that you are pointing at, but I think you are over-estimating the relative force.

We are importing something like 12% or 13% of GDP, i.e. the price of imported goods is not that important comparing to the falling asset prices. $2 trillion of housing wealth disappeared last year, another $3 trillion coming this year. In Detroit, you can buy a house for $5 already, less than 2 gallons of gasoline. You can buy a whole street for the price of one gas tank. And you call this inflation?

>>> Who is going to pay all the outstanding debt?

Of course it will be inflated, but this what will happen in future, after the recession is over. Right now the economic collapse is eliminating the price pressure, but it is slow like watching the paint to dry, so I expect the inflation to be the topic for this year, the visible price deflation will not happen until 9-12 months from now (IMHO).

This one goes to some of my issues:
“In Detroit, you can buy a house for $5 already, less than 2 gallons of gasoline. You can buy a whole street for the price of one gas tank. And you call this inflation?

The reason a 5 dollar house is not an indication of deflation is the same reason that buying a farm in Zimbabwe would be excessive at $5: It is dangerous.

What is happening is that people are not buying houses because the cost of life (notice I did not say cost of living) is too high. Ordinary goods like gas and milk are pushing aside housing as an item to spend money on.

Let’s try another example. Let’s say you had two sacks of dog manure, and one was ten times the size of the other. What would the relative value be? Let’s say you had $10 trillion in dollar currency in one bag and $100 trillion in another. What would the relative value be? What I am saying is that even if currency deflation takes place, the value of that currency may not increase, if that currency is not perceived to have value.

So if you collapse housing, all that “money” disappears, but if no one is buying housing then the cost of everything else may go up. Classic inflation in the face of massive currency deflation. This happened in the past when interest rates went up because of the perception of inflation, but house prices collapsed because the interest rates went up. We are seeing this now with Ts moonshotting.

In this analysis inflation is on non-levered items, and deflation occurs on levered items.